Contract For Differences (CFD) – Chapter 4: The Main Features of the CFD’s
One the key features of CFDs trading is the ability to leverage your trading through margin trading. What this mean in essence is that you are taking out a “loan” from your brokerage firm to purchase the full value of the CFDs. By doing so, you are able to purchase a bigger volume of CFDs than would be possible with your own money in your trading account.
Therefore, with margin trading, an investor only pays a percentage of the stock price. Had the investor actually brought the stock in the equity market, he would have to come up with the full amount of the value of the stock before he can purchase it.
Margin trading can entail paying as little as 5% of the total value of the shares as a down payment for the CFDs. Because the investor is not required to buy up the underlying shares, his holding “value” is actually many times greater than investment through the traditional equity market.
With CFDs trading, there is no expiration date on the CFDs. The market position is only closed when the investors wish to realize his gains or to limit his losses.
To start a trade in CFDs, you only need to fund what is called the “initial margin”. The whole point about margin trading is for leveraging. When you leverage your trading with margin, you hold a larger volume of the CFDs and thus this allows you the possibility of realizing a greater amount of profit than possible with traditional equity trading.
There is one very important aspect of margin trading which an investor must bear in mind. The ratio of the margin to the initial value of the CFDs contracted must be maintained at all times. Thus, if your CFDs are showing a positive gain, there is nothing for you to worry about. However, if the market decline and causes you to incur losses, this will result in the ratio of the margin to the initial cost of the CFDs to fall. If this ratio falls below the stipulated level, than your brokerage firm will subject you to a “Margin Call”. What this mean is that you will have to deposit additional money into your trading account to maintain this ratio. If you fail to do so, your brokerage firm will liquate your holding and close your market position.
Risk Management Facilities:
Due to the higher risk associated with margin trading, the majority of CFDs providers also have additional comprehensive mechanisms to help investors to limit their losses. These included Stop Loss & Limit Order Facilities which investor can utilized for part of their risk management strategy.
No Stamp duties:
As you are not purchasing the actual underlying assets, you are not subjected to the high cost of stamp duties. As compared to the traditional equity market, you will achieve a saving of 0.5% for not having to pay this transactional cost.
You are also liable for commission charges as with equity trading. This commission payable is calculated based on the amount traded and not on the margin amount.
As you are trading CFDs in margin, you have to pay an interest rate on your overnight open position. Note that Long CFD position is subjected to interest payable. On the contrary, Short CFD position will earn interest.
The rate payable or earned varies between brokers and is normally a percentage above or below the London Inter Bank Offered Rate (LIBOR). The rate is calculated daily by multiplying the interest rate to the daily closing value of the CFDs. This daily closing value obtained by multiplying the volume of shares specified in the CFDs to the daily closing price of the shares. Thus, unless there is no price movement, the daily closing value will change daily as well.
Trading of Shares & Indices with CFDs:
Trading CFDs allows you to have holdings in shares and indices without actually buying the actual asset. As some CFDs providers also allow trades in currencies and other market sectors, CFDs also permit you to have a wider choice as to the type of investment that that you wish to invest in.